Value 2016

There is an old stock market saying that the market “climbs a wall of worry” – well, if that is true, 2016 should be a great year.

The saying refers to the ability of the market, while investors are bombarded by bad news, to make gains. If bad news is in fact good news, we’re looking great – investors are reeling from the horrendous start to the year, with the US markets racking up their worst opening week in history.

We have worries about the outlook for the global economy, concern about the Chinese economy’s downturn (real numbers, not official), the resultant depreciation of the yuan and the fears that engenders for emerging economies, anxiety that central banks, which have been the major drivers of market rises, are running out of ammunition, and slumping commodity prices, led by oil.

On top of that we have the usual stew of geo-political concerns, most particularly a worrying deterioration of relations between Saudi Arabia and Iran – with all the attendant fears of Sunni-Shia conflict that holds – the reported testing of a hydrogen bomb by the North Korean regime, and very real worries that Europe is facing a loss of faith in democratic politics.

But there is some good news behind these concerns – and it’s that good news that will – hopefully, eventually – provide the footholds for the market to climb the wall of worry.

First, the Federal Reserve’s December rate hike – the first in seven years –has to be seen as a vote of confidence in the US economy, based as it was on solid US jobs growth, which bolstered the Fed’s confidence that real US GDP growth would amount to at least 2 per cent for the next three years. That does not sound euphoric, but while global growth concerns remain and commodity prices are still under heavy pressure, that means that the US economy is back in business. That has to be a good thing.

US employment rose by a much stronger-than-expected 292,000 in December – well ahead of the 200,000 increase analysts expected – and importantly, November’s initial result of 211,000 added jobs was revised to a 252,000 rise in payrolls. Furthermore, average hourly earnings grew at 2.5 per cent year-on-year, for the fastest pace in nearly six years. The importance of the wages growth cannot be under-emphasised – it has been the missing link in the labour market data. For what it’s worth, the trend of the US jobs figures gave the Fed confidence in expectations of continued gains in the US economy.

China is a different case altogether. It is well understood that the Chinese economy is making the transition from being driven by fixed-asset investment and manufacturing exports to an economy driven by consumer spending and service. As it makes this transition – which many emerging economies have made before it – China’s economic growth rate necessarily declines: officially China’s economy grew by 7 per cent in 2015, and is expected to come in at 6.8 per cent in 2016. Real growth could well be much less than that. Nevertheless, it is clear that the days of double-digit growth are far behind us, and the decreased demand for commodities from China shows this.

Longer-term, the growth of the Chinese consumer and services economy will provide huge opportunities for Australia, but for the moment, concerns over China’s slowing economy and depreciating currency are very real. Usually, ructions on the Chinese sharemarket would not unduly bother the world – it is far less closely linked to the economy than a developed-world stock market like the US or Australia is – but in this febrile scenario, the plunging index levels and enacted circuit-breakers of the average day on the Shanghai exchange become another reason to worry.

Indeed, China’s malaise has flowed in to the World Bank’s first forecast for global economic growth in 2016, which saw the 2016 growth estimate downgraded from 3.3 per cent (in June 2015) to 2.9 per cent – mainly on the back of slowing output in China, and Brazil. While there are bright spots in the global economy – namely, the momentum in the US, a pick-up in European growth (from an estimated 1.5 per cent in 2015 to 1.7 per cent this year) and bright spots in South-East Asia and East Africa – the emerging markets are seen as negating this. The World Bank tips Japan to boost economic growth from 0.8 per cent in 2015 to 1.3 per cent this year, but it describes the Japanese recovery as “fragile.”

In Australia, the Reserve Bank has plenty of scope to cut interest rates if necessary, with the cash rate sitting at 2 per cent, and Canberra could also add stimulus if really required. But Australian consumers are still spending – retail sales in November were 4.3 per cent higher than a year before – and the low oil price is boosting consumer confidence.

While this spending continues, domestically based companies will still be able to show revenue and profit growth – and even more importantly, maintain (or even lift) their dividends. Australian dividends saved investors from a loss last year, and while dividend expectations cannot ever be considered 100 per cent certain, fully franked dividend-paying shares are likely to be the safe haven of choice for Australian investors again this year. Nominal dividend yields of 4.5 per cent–6 per cent are relatively common on the Australian sharemarket, and that is where most investors will look to ride out the prevailing market turbulence.

James was founding editor of Shares magazine, and oversaw one of the most successful magazine launches in Australia. He has also written for BRW, Personal Investor, The Age and Management Today, and was subsequently personal investment editor at The Australian and editor of financial website, investorweb.com.au